Using real options to evaluate ethanol plant expansion decisions
Purpose - The purpose of this paper is to investigate how to incorporate market price risk into investment decisions. The investigation focuses on investments to expand ethanol production facilities. The model is used to determine if such a real option approach can explain recent changes in the level of plant investment activity. Design/methodology/approach - The paper demonstrates how real option analysis and Monte Carlo simulation can be used to evaluate ethanol plant investments by using available historical industry and market price data. We focus on existing small-to-medium, dry milling plants and the real option to expand the scale of operations. The binomial option pricing model is used to identify optimal strategies. Findings - Increasing profitability and volatility appear to favor the strategy of investing during 2005-2007. However, when the prices of corn and natural gas rise and plant profitability declines during 2007-2008, the best strategy is increasingly to either postpone the investment or reject the decision to expand. Originality/value - This paper is a first application of real option analysis to ethanol plant expansion decisions. The methodology used in the paper can be adapted by analysts, investors, and lenders in the ethanol industry to improve their investment analyses.
Volume (Year): 69 (2009)
Issue (Month): 1 (July)
|Contact details of provider:|| Web page: http://www.emeraldinsight.com|
|Order Information:|| Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK|
Web: http://emeraldgrouppublishing.com/products/journals/journals.htm?id=afr Email:
When requesting a correction, please mention this item's handle: RePEc:eme:afrpps:v:69:y:2009:i:1:p:23-35. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Virginia Chapman)
If references are entirely missing, you can add them using this form.